Interactive Investor

Five top picks for the future

18th December 2014 11:15

Richard Beddard from interactive investor

And now for something completely different. A list of shares that will not necessarily profit investors in 2015. You'd need to be more patient than that.

This list is probably unlike any of the other lists you will see published as the New Year approaches. It's been put together without any thought about how the companies' share prices will perform over the coming year.

They may do well. If they do, hold the plaudits. It will be the result of nothing more than luck. I've selected these shares for the long-term. They're plucked from the fifty-odd shares tracked in the Share Sleuth portfolio spreadsheet, the companies I would consider adding now. They're good businesses, at attractive prices, that I include in a diversified portfolio of 25 shares.

The news is not all good though. Rolls-Royce has offered shareholders the firmest guidance. It's not going to grow in 2014 or 2015. Profit fell in the first half of Castings' financial year and its unlikely to make good the difference in the second half. Goodwin may face a headwind in lower oil prices. ITE is at the centre of a geopolitical and financial crisis. Perhaps Dewhurst will have a good 2015.

Challenges like these give long-term investors the opportunity to buy shares in good companies at low prices. If we hold them through what's left of the challenging times and beyond, we should be rewarded for our courage and virtue. The underlying strengths of the companies gives us the confidence to hold them, strengths I may not be able to convey in the short format of this article, especially as, with good reason, I tend to focus on the risks. The hyperlinked company names in the text lead to more detailed analysis.

I re-evaluate shares when companies publish full-year results, and if I discover new facts that change my opinion.

Dewhurst [460p, earnings yield 17%]

Of the ninety-odd companies I track, Dewhurst could be the most undervalued. The company is a manufacturer of push-buttons and components for lifts, ATMs, and railway carriages, as well as bollards and signage for roads. Although its illiquidity is off-putting for some, it shouldn't be off-putting for long-term investors. Dewhurst is a respected specialist, which probably explains its record of high profitability, maintained in the year to September 2014.

Castings [410p, earnings yield 11%]

Castings manufactures iron castings in foundries in the Midlands, which it also machines into axle, suspension, exhaust, transmission and gearbox parts for big European truck and car manufacturers. It sounds like an old fashioned business, but it's highly technical and through financial prudence and continuous investment the company has found a way to prosper in most years, even when its customers can't. After a disappointing first half when a forecast increase in demand floundered, profit in 2015 is likely to be lower than it was in the year to March 2014. That shouldn't worry long-term investors.

Goodwin [2,775p, earnings yield 9%]

Goodwin's full-year results for the year ending in April 2014 showed another year of strong growth for a company that has grown strongly for decades (with modest interruptions). It manufactures valves for oil and gas pipelines, rigs, refineries and applications in the energy, chemicals, fertiliser, and water industries. Subsidiaries also manufacture steel castings, radio antennae, and process minerals used in casting.

Lower oil prices may lead to lower investment by oil producers, limiting growth more than it has in the past, but Goodwin is confident that oil consumption will continue increasing in the decades to come and the company is, from the incentives it pays executives to its commitment to investment, built for the long-term.

Rolls-Royce [820p, earnings yield 9%]

The immediate prospects for Rolls-Royce are not exciting. The company has warned shareholders to expect revenue to be slightly below the high levels reached in 2013, and profit to be much the same as they were then when it reports results for the full-year to 31 December. Most of its businesses should grow modestly but the Defence Aerospace division is contracting due to NATO budget cuts.

The company is buying back shares, a contentious issue for investors. Shareholders benefit because the proportion of the company we own increases if there are fewer shares listed. Effectively, Rolls-Royce is investing on our behalf. But there's an opportunity cost. The money may earn higher returns over the long-term if it is invested in new projects instead. If the company paid higher dividends instead of buying back shares, shareholders could decide for themselves where to invest the money, and they might decide to invest it elsewhere. Suspicion falls on directors because, other things being equal, buybacks also juice up earnings per share by reducing the number of shares and may increase profitability, depending on how you measure it. These ratios often trigger bonus payments.

We can't discount the possibility directors are motivated by these incentives and the buyback is an admission that due to economic conditions and a period of reduced military spending it can't find highly profitable new projects to invest in. But Rolls-Royce's earnings yield roughly implies a return of 9% even if the company doesn't grow. It says it won't in 2014 and 2015 but, given its qualities and its conservative strategy summed up by its focus on four other "c's": customer, concentration, cost, and cash, it probably will prosper over the long-term.

Since Rolls-Royce is probably a good investment, the buyback probably is too.

ITE [130p, earnings yield 13%]

I've included trade exhibition organiser ITE in my favourite five even though the Rouble is plummeting against the dollar and the pound in a currency crisis that has surpassed the one Russia experienced in 2008. If the pundits forecasting a contraction in the Russian economy of 4% or more next year are right, the crisis threatens to rival 1998. Then, the Rouble reportedly fell by three quarters against the dollar, interest rates touched 150%, the Russian economy went into deep recession and Russia defaulted on its debt.

ITE earns 60% of revenue in Russia, and more in Ukraine and other countries still in its sphere of influence. A quarter of invoices are paid in Roubles. Profits will be diminished by payments in a depreciated currency, but it's what the currency collapse symbolises that is most scary. Russia's prosperity, and that of the businesses that exhibit with ITE, depends on oil production, and low oil prices, as well as sanctions imposed by countries opposed to Russian support for separatists in Ukraine are driving the country into recession. The length of the recession depends on the complex interplay of demand for oil, which is weakening due to slowing growth in China, supply, which is bountiful due to fracking in the USA, and geopolitics.

I can't untangle these threads and weave an accurate prediction of what will happen, but I think ITE is a firm for the future. It's a resilient and highly profitable business that has withstood crises before. Investors are less resilient. In previous crises the shares fell 70%. Today, they're over 60% below their high of October 2013.

In its performance, and the performance of its share price, ITE proved fickle investors wrong in 1998 and 2008. I think there's a good chance it will again.

Since ITE is susceptible to Russian crises, but is nevertheless a very prosperous company, the time to add the shares is not when the price is high and investors have forgotten the risks of business in Russia. It's when the news is so bad most investors won't even think about investing. That's easy to say, but very difficult to do. I’ve already misjudged it once.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.


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